The Three Innovations that Tokenized Securities Will Bring (Part #3)
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IV. How Should an STO Platform be Built?
1. Step-by-Step Approach
Given the ongoing absence of finalized regulations and laws pertaining to STOs in Korea, an incremental strategy becomes essential. To achieve a unique business identity through product variation, it’s vital to give precedence to crafting an issuance platform specifically for exclusive off-market products. Moreover, establishing linkages with current systems is critical to avoid duplicative investments. Concurrently, in pursuit of long-term objectives, there’s a need to contemplate building foundational structures by interconnecting nodes with other brokerage firms and considering the incorporation of Layer 2 technologies (like subnets), contingent upon the progress and validation of public chain technology.
Figure 18. Competition will Begin Based on the Core of Financial Institutions ‘Products.’
2. Initial STO Platforms
There’s a growing need for standardized models in the STO platform to streamline system establishment. Despite varying IT systems across brokerage firms, they face similar hurdles and policy decisions when building STO platforms. These challenges include identifying primary customer service channels, deciding on ledger creation location (main system or STO platform), structuring accounts, managing product information (integration or separate), and determining processing locations for orders and evaluations, among other considerations. We’ve classified the essential system configurations for phase one as outlined below.
Figure 19. Stage 1: To-Be STO System Structure
Specifically, certain domains that are anticipated to necessitate integration based on the utilization of existing legacy systems encompass customer data, contract particulars, comprehensive account setups (account initiation), cash flow management (deposits and withdrawals), financial bookkeeping, and transactional payments. Integration of these segments with the ST system using methods like API is strongly advised. Moreover, functions like evaluation (ST ledger) and payment execution are imperative for cash management activities, alongside accounting procedures involving the general ledger and interfaces with financial accounting systems. In the initial phase, it’s pivotal to link the STO platform to legacy systems while ensuring they aren’t overly strained, facilitating rapid adaptation to the market within a brief timeframe.
3. Suggestions from INF CryptoLab
To effectively construct an STO platform, understanding three fundamental elements and charting a long-term course is imperative.
First and foremost is grasping the objectives of the STO platform. These objectives should transcend mere short-term profit or immediate service impact; they should serve as a cornerstone in acquiring clientele and venturing into the burgeoning digital asset market.
Secondly, it’s pivotal to delineate a clear target system aligned with governmental regulations. Developing an MVP (minimum viable product) while encompassing functionalities necessary for self-issuance, agency, on-exchange, off-exchange transactions, and seamless integration with external systems (such as KRX, KSD, etc.) should be a gradual progression following governmental guidelines.
Thirdly, agile validation of services becomes essential. Rather than the linear waterfall method — proceeding from problem definition to ‘To-Be’ process establishment to construction — embracing the agile methodology, which involves simultaneous establishment of business direction, defining ‘To-Be’ processes, and system construction, is crucial for effectively adapting to the evolving STO market.
Long-term strategizing shouldn’t solely focus on STO strategies; it’s crucial to chart a course that encompasses entry into the crypto market by leveraging STOs as well. The crypto market offers diverse business prospects like cryptocurrencies, NFTs, DeFi, CBDCs, etc. Companies stand to benefit from reduced customer acquisition costs, global reach, heightened intangible asset value, and talent acquisition via crypto ventures. This approach lays the groundwork for future growth momentum, innovative business models, and increased corporate value.
Figure 20. Future of Security Tokens
V. Examining STO Cases in the United States
1. BCAP, the First Security Token in the U.S.
STO issuance in the United States predates Korea by a significant margin. The inaugural STO case in the US was the BCAP token launched by Blockchain Capital in 2017. Utilizing the ERC-20 format on the Ethereum network, the BCAP token conferred ownership and entitlements linked to Blockchain Capital’s third fund, the Blockchain Capital III Digital Liquid Venture Fund.
Using the BCAP token, the fund conducts investments with the raised funds, distributing investment gains as an Evergreen Fund token upon capital recovery. Twenty-five percent of the fund’s profits, alongside a 3.5% management fee, are directed to Blockchain Capital. Of the remaining investment profits, 50% are earmarked for fund reinvestment, while the other 50% is allocated to token holders based on decisions made by the fund manager.
Figure 21. Blockchain Capital BCAP Token
Figure 22. BCAP Token Sale
Figure 23. BCAP Token SEC Registration
Collaborating with the Argon Group, Blockchain Capital gathered tens of millions of dollars via crowdfunding on Token Hub. The fund swiftly gained immense traction, closing a mere 6 hours after its announcement due to high demand.
Token Hub, responsible for BCAP token sales and distribution, obtained LP (Limited Partner) shares in Blockchain Capital’s fund by pooling funds from diverse investors. Following this, it allocated tokens to investors according to this ownership arrangement.
Figure 24. Blockchain Capital and Token Hub Token Securities Sale Structure
BCAP underwent the US securities declaration process and was marketed through Regulation D’s Rule 506(c), catering exclusively to accredited US investors. Simultaneously, it was also marketed through Regulation S, streamlining sales without additional SEC registration steps for non-US investors.
A sum of $10 million tokens was sold at $1 per token, accumulating a total of $10 million. Upon SEC registration document submission, 745 investors were confirmed as participants. While the exact ratio of accredited US investors remains undisclosed, it’s inferred that most of the investments came from non-US investors via Regulation S.
Figure 25. BCAP Token Raised Amount and Investors
Reviewing the disclosure information of Blockchain Capital’s BCAP token in Q3 2023 unveils the diverse portfolio held within the firm’s third fund, encompassing assets like Circle, OpenSea, Ripple, among others. The Net Asset Value (NAV) reflects a multiple of 14.1 times the initial fundraising amount, mirroring the BCAP token’s NAV at the point of sale, also reaching 14.1 times the sale price, totaling $14.10.
Figure 26. BCAP Token Status (2023)
BCAP, as the inaugural securities token case in the US, faces notable criticism. Substantial concerns include legal uncertainties, unclear profit distributions, and the rights of token holders. The creation of an Evergreen Fund as a securities token brings complexity due to the absence of an expiry date, granting Blockchain Capital the authority to alter legal terms, posing several investor rights challenges.
Despite the initial challenges of tokenized securities, the BCAP token holds immense historical significance as it pioneered US securities tokens and demonstrated potential functionality. Presently, newly released securities tokens are undergoing distribution and issuance in an advanced format, addressing the deficiencies witnessed in BCAP.
2. INX Token
The INX token stands out as a prime example of tokenized securities granting shareholders potential rights to dividends and profits rather than adopting a venture fund structure.
Functioning as an SEC-registered platform for tokenized securities (ST) trading and IPOs, INX Token Securities Platform introduced the INX token. This security token is structured to reward token holders with 40% of the company’s profits once it attains profitability.
In a distinct process from Korea’s handling of securities and token securities, INX successfully raised 85 million USD from international investors through the official SEC registration procedure employing Form F-1. At present, INX remains actively engaged in supporting diverse companies and projects in their IPO endeavors through multifaceted initiatives. Additionally, it operates INXONE, a broker-registered exchange for token securities.
Figure 27. INX Token
Figure 28. INX Token SEC Registration
There’s additional recent information concerning the Republic Note, issued by Republic, an investment firm registered with the SEC. This note offers entitlements to funds, shares, and dividends. Functioning as a tokenized security, it disperses rights related to 623 companies, 765 assets, and dividends linked to Republic’s Evergreen Fund. The sale of Republic Note to non-US investors will kick off on December 6th via the INX platform.
Tokenized securities have extended their presence beyond businesses and funds, finding application in diverse realms like real estate, NFTs, high-value artworks, solar panels, and other sectors.
VI. Conclusion
Tokenized securities are still in their infancy and are on the cusp of further evolution. However, to achieve genuine mainstream adoption of blockchain, these technologies need to shift their perception from merely being tools catering to a niche group of cryptocurrency enthusiasts to being acknowledged as technologies tailored for a broader audience, spanning diverse financial sectors, Web2 companies, and the public.
At present, several services are emerging that aim to integrate real-world assets (RWAs) and a wide array of financial services with blockchain technology. For instance, initiatives like Chainlink’s CCIP seek to onboard numerous existing global assets onto the blockchain by leveraging SWIFT payment networks, while MakerDAO is creating and executing systems for distributing US bond yields. Additionally, there’s a range of RWA solution providers and multiple Central Bank Digital Currency (CBDC) initiatives at the national level, all showcasing this ongoing trend.
STOs stand as innovative instruments poised to introduce novel advancements in the financial market by connecting blockchain with financial institutions and offering the public experiences related to tokens. Coupled with the three innovations outlined in this article, the proactive response from brokerage firms instills hope for the growth and development of the STO market in South Korea.
Appendix
- Issuance of tokenized securities in Korea is conducted by the issuer or an account management institution (securities firm, bank, etc.), and after assessment and management by KSD, distribution occurs on the KRX (Korea Exchange).
- Issuance Process: ① KSD (Korea Securities Depository) registration assessment → ② Token creation and transfer by the issuer or account management institution → ③ Custody management by KSD
- Distribution: ④ Over-the-counter market (brokerage by brokerage firms/OTC brokers) / ⑤ On-exchange market KRX (Korea Exchange) → ⑥ Settlement through KSD
Figure 29. Distinct Mechanism for Issuing and Dispensing Tokenized Securities in Korea
